Usage vs Subscriptions
Arrears versus Advance billing
- Billing in Arrears: Money is paid after services are provided, at the end of a billing period
- Billing in Advance: Money is paid before services are provided, at the beginning of a billing period
Usage-based plans are are billed in arrears.
Why is this?
Your electric company charges you based on the how much energy you use each month. One month you might consume lots of energy. The next month you might be on vacation, out of the house, and never even turn on alight. Your electric company cannot charge you in advance, like Netflix, because they have no idea how much energy you're going to consume in a given month.
This model is known as usage-based (or consumption-based) billing. It is common among utility companies, and more and more, software companies. Twilio's text messages; Algolia's searches, Stripe's payment processing -- none of these API companies can know how much to charge you each month until after you've used the service.
Graduated and Volume-based Usage Pricing
When defining a Usage plan, you'll also need to choose whether to use Graduated or Volume-based pricing. In short, this usage type configuration simply governs how lower-volume requests are billed as customers usage scales up.
- Graduated Pricing: Each request (or dimension) is billed in accordance with the pricing tier in which it falls
- Volume-based Pricing: Each request (or dimension) is billed in accordance with the final pricing tier reached in a given billing period.
To illustrate, let's consider a simple example of a plan with two pricing tiers:
- $1.00 per request up to 100 requests
- $0.90 per request above 101 requests
Let's assume a customer makes 125 requests in July.
- With Graduated pricing, that customer would pay $122.50 ($1.00 100 + $0.90 25), where each request is billed in the tier in which it falls.
- With Volume-based pricing, that customer would pay $112.50 ($0.90 * 125), where each request is billed at the $0.90 tier, as that was the total volume of the period.
Subscriptions are billed in advance.
Why is this?
When you sign up for Netflix, you are charged immediately, in advance, for the month ahead. Netflix knows exactly how much your subscription costs before you buy it. Nothing about your consumption is going to impact your pricing. You could binge watch all month long, or you might never turn on your TV. Either way, Netflix will charge you the same amount, every month, at the start of the month.
This model is known as a subscription. You may subscribe to many things at once. Perhaps your cable package includes HBO and Showtime, and you're charged a bit more than your neighbor who has only basic cable. But no matter how much TV you consume, you'll be charged the same amount for your subscription.
Which is right for you?
Which model is right for you depends heavily on your business. There are lots of ways to model pricing, and there are pros and cons to most. And of course, what's right for one business may not be right for you. In fact, what's right for your business today might not be right for your business tomorrow.
Combinations of Usage-based Plans and Subscriptions
Billing is never simple, and of course there are ways to blend usage-based plans with subscription billing. There are some cases where it may be appropriate to charge your customers in advance (with a subscription plan) and draw down on that prepaid balance over the course of the month with a usage-based plan.
If you have questions about your business model or want to talk pricing strategy, we happily provide free pricing consultations for each of our customers. Send us a message and we'll find some time to chat.
Updated 5 months ago